US and Europe

US Federal Reserve announce stimulus targets

Friday December 14, 2012Hugh Dixon

On 12th December 2012 the US Federal Reserve announced, for the first time, its explicit stimulus thresholds. The Federal Reserve announced that it will hold official rates at 0.25 percent for as long as the US unemployment rate was above 6.5 percent, and that inflation two years out is no more than 0.5 percent above the Federal Reserve 2 percent long-run goal.

The US Federal Reserve also announced that it would extend its program of purchasing mortgage-backed securities at the pace of US$40 billion a month; stopping at the end of the year. From the start of 2013 they will purchase longer-term Treasury securities at the pace of US$45 billion a month.

The policies being used by the US Federal Reserve is designed to maintain downward pressure on longer-term interest rates offered to all customers, support the mortgage market, and help to make broader financial conditions easier for US businesses and consumers.

Focus on lowering unemployment

The US Federal Reserve’s stimulus program is focused on lowering unemployment. The aim of the US Federal Reserve is to purchase mortgage-backed securities, encouraging banks and other mortgage companies to provide more and riskier mortgages to customers. Ensuring people can sell their houses if they can no longer afford it or sell and move to another location with better employment opportunities.

Also, The US Federal Reserve is helping to curb unemployment through the downward pressure they are maintaining on interest rates. Maintaining lower interest rates, the US Federal Reserve encourages banks and lending companies to provide cheaper loans to US companies seeking to invest in their businesses or other businesses. This will enable companies to grow and employ more workers. Why is the US Federal Reserve doing this?

The US economy is still weak, with a fiscal cliff looming at the end of the year, threatening to send the US economy back into recession. With the official rate at 0.25 percent since December 2008 the US Federal Reserve is unable to lower this further to stimulate the US economy. Therefore it has to use other financial levers, such as purchasing securities, to achieve its goal of stimulating the US economy.

Drop in unemployment

Unemployment has dropped from a high of 10 percent in October 2009, to 7.9 percent in November 2012. However, the current pace of recovery in the US economy is still slow and the unemployment rate has been decreasing only gradually over the last few years. This means that the US Federal Reserve may need to continue its program for another year or two if it is targeting unemployment to move below 6.5 percent.